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Article: November 2017: Asia-Pacific Litigation Update

Business Litigation Reports

Safe Harbors in, Ipso Facto Clauses out: A (Long Overdue) Shake Up of Australian Insolvency Laws.
The federal government has this month passed a suite of insolvency reforms with the consequence of significantly elevating the levers available to companies in distress (or in administration), and redistributing control away from key creditors.

The Australian insolvency regime, as a consequence of the major banks that control most business and consumer lending, can be accurately labelled as a “creditor friendly” environment. It avails considerable powers on creditors and effectively disconnects a distressed company from its managers, its board and shareholders, quite distinct from the U.S. Chapter 7 and Chapter 11 regimes.

The current amendments that have now passed both houses of parliament (below) will have the effect of bridging part of the divide between individual creditor-interests and the company’s survival in a pre-insolvency context, and maximizing a company’s value or restructure prospects if it is ultimately moved into a formal insolvency/bankruptcy process.

There are two critical (and principal) changes to the Australian insolvency regime:

  • Invocation of a new “safe harbor rule”. In the Australian pre-insolvency landscape, where companies are facing financial distress, and wavering on insolvency, its directors (including, importantly, its non-executives who are typically disconnected from its day-to-day operations) can be held personally liable for the company’s debts if the company is “insolvent” at the time of their incurrence, pursuant to Australia’s insolvent trading laws: Corporations Act 2001, section 588G. The consequence of this is that in many cases, directors that are sitting on boards (and receiving modest director-fees) can be personally liable for vast debts incurred by the company they oversee during a period of financial distress. Unsurprisingly, under this regime, the scent of financial distress has been enough to cause them to “call in the administrators” – a step which has an immediate effect of diminishing the business’ value. And while the personal liability ‘stick’ was intended to help preserve assets (for the benefit of all creditors), in practice it has the effect of discouraging boards from proactively pursuing informal turnarounds or restructures. The new safe harbor rules, which have now come into effect, will allow boards to invoke a turnaround strategy immune from the risk of personal liability for possible insolvent trading, and that immunity will remain in place for as long as the turnaround strategy continues to be justifiably pursued.
  • Revocation of ipso facto contract termination rights. The other major change to the insolvency laws concerns the operation of ipso facto clauses in contracts. Under the existing legal framework, contracting parties are able to (and nearly always do) incorporate termination or step-in rights upon the occurrence of an ‘insolvency event’. Such rights create considerable uncertainty for businesses in an administration / bankruptcy process, as their previously valuable contracts or essential supply chains become immediately terminable by their counterparty as a consequence of that insolvency. The corollary of this (in an administration process designed to preserve value) is enormous value leakage, and the transfer of important leverage away from the company in distress, and in favour of its contracting counterparty (who then hold valuable termination rights).
    The new laws, which will come into effect in July 2018, will invalidate any ipso facto clauses from contracts; meaning the ‘insolvency event’, if it occurs, will not disrupt the business’ status-quo or its favourable contracts (except as determined by the administrator him or herself). Ipso facto clauses have for years now consistently hampered, and caused harm to companies seeking to utilize administrations as a tool for essential formal restructuring – the current change should mark the death knell for such obstacles to corporate turnaround, and provide a much needed transfer of leverage to distressed companies. (In a last-minute arm-wrestle with industry – mostly with Australia’s largest banks and corporates – the Australian Government agreed to amend the final bill to only apply to ‘new’ contracts entered into after its commencement, meaning there will remain a few additional innings in the existing regime before the curse of ipso facto clauses are finally at an end.)

In summary, the current changes will together encourage the proliferation of a proactive turnaround culture amongst Australian corporates, and remove some of the hurdles that historically benefited only a distressed company’s secured creditors and financiers.
Practically, the changes will lead to companies proactively engaging with restructuring lawyers and advisers at an earlier stage (with the benefit of ‘safe harbor’), and in pursuit of their own turnaround before (or in lieu of) handing the company’s keys to an external administrator or bankruptcy trustee.

Japan Enacts Changes to Protect Consumers.
Changes to three different laws evince an effort by Japanese regulators to offer better protection to Japanese consumers.

First, changes to Japan’s Consumer Contract Act were recently implemented to advance the interests of individual consumers involved in transactions with business operators. The changes came into effect on June 3, 2017.

Under the revised Consumer Contract Act, consumers can now more easily rescind agreements if they misunderstood certain conditions. The ability to rescind agreements is not without limit, however. The new balance struck by the law allows consumers to rescind agreements for goods and services where the contact involves “important matters,” defined more broadly now to mean matters essentially concerning consumers’ lives, bodies, or important assets. For example, consumers can now rescind an agreement to buy items like tires for their car if they made the agreement believing a false claim that the car was now dangerous to drive without them.

In addition, in light of the aging population and concern for excessive and unnecessary purchasing by a class perhaps more easily misled, the Act more regulates contracts involving excessive purchases.

In addition, under the revised Act, certain clauses will no longer be recognized. The Act permits nullifying any clauses, in part or in whole, that exempt business operators from liability for damages, that stipulate the amount of the damages paid by consumers, or that unfairly harm the interests of consumers, including clauses that would waive or limit a consumers’ right to cancel where there are latent defects in the goods purchased.

Second, amendments to the Civil Code were enacted on May 26, 2017, and will take effect within three years. While the amendments covered a number of areas, including changes to the statute of limitations and revising statutory interest, certain changes here as well were directed toward better protecting Japanese consumers.

Japanese law currently has no general regulations governing “general terms and conditions,” which are often found in one-sided transactions, such as when purchases are made from internet sites, or when consumers buy insurance. Provided they did not violate other laws, business operators were free to include favorable terms even though it was understood that many people did not read the general terms and conditions when making purchases. The revisions will add a requirement that the consumer takes some steps to affirmatively agree to those terms, or that the business show that the terms were presented to the consumer in advance of the agreement. Moving forward, businesses can also only make unilateral changes to the terms of the purchase if the change benefits the consumer or is otherwise reasonable and not just for the business’ benefit.

And third, amendments to the Financial Instruments and Exchange Act were made and will take effect by May 24, 2018. These revisions add a Fair Disclosure Rule and a registration requirement to better protect Japanese investors. The new registration requirement applies to high-frequency trading companies, which are currently not required to register. The amendments add reporting requirements for entities making frequent trades, as defined in the Act, so that the Financial Services Agency can ensure that they are properly managing their trading system, have appropriate asset balance, and report its strategy for high-frequency trades.

China’s New Cybersecurity Law, Effective June 1, 2017. China’s new Cybersecurity Law took effect on June 1, 2017, marking an important milestone in China’s push to tighten control of domestic data. The Cybersecurity Law defines parameters protection for personal and sensitive data; it also imposes a series of requirements on operators of networks and China’s “critical information infrastructure.” However, because the new law provides only a framework of rules, actionable regulations and implementation plans are still under formulation.

The Cybersecurity Law imposes a strong set of obligations on network operators. It defines a “network operator” broadly as any “owner or administrator of network or a network service provider” and will likely encompass any entity with an intranet. The network operators, prior to collection of personal data, are required to disclose the method, purpose and scope of data collection, and also obtain consent from individuals involved. The operator may not share the data to third parties without the individuals’ consent. A separate set of obligations applies to “important data”—defined broadly in proposed draft regulations as any data closely related to national security, economic development, and societal interest. For instance, in e-commerce, it would include accounts, transaction records, data regarding consumption habits, and credit information. According to the Cybersecurity Law, as a general rule, this data must be stored inside China. For both personal and “important data”, the operator can only export the data out of China if it is for a “legitimate business purpose”, and it must first perform a security assessment; and additionally, for personal data, it must inform the individuals and obtain prior consent.

For all types of data stored by a network operator, the operator is required to implement a series of standard protective measures, including: anti-virus protection, data encryption, anti-hacking safeguards, and self-reporting to authorities of any data theft or unlawful disclosures (and in the instance of personal data, notification to the affected individuals and efforts to cure).

Furthermore, the Cybersecurity Law has heightened requirements for “critical information infrastructure” (“CII”). The Law defines CII as any network or information system the destruction or disclosure of which may harm national security or the public interest. According to draft regulations, it would include networks managed by companies in financial, online services, cloud computing, big data, food and pharmaceuticals, and/or chemicals industries. Although authorities are preparing guidelines for what exactly qualifies, it is quite clear that the scope will be broad. The heightened duties CII operators bear include extra protective measures (e.g. employee training and security background checks on key personnel), security reviews before purchase of any online products the use of which may affect national security, and submission to spot-checks by authorities. For any security assessment before export of personal or important data, the CII operator must notify the assessment to authorities and obtain their approval before proceeding. Administrative penalties for violations involve fines of up to RMB 1 million, and in serious circumstances, the suspension or even termination of business licenses. The Cybersecurity Law also states that violations could constitute offenses under the Criminal Law.

The potential implications of the Cybersecurity Law for companies operating in China are profound. Any company with its own intranet will likely qualify as a “network operator,” and many will also be CII operators based on their industry or business. For those affected, resources needed to ensure compliance will likely be substantial. However, the degree to which the requirements pose new obstacles will largely depend on forthcoming regulations and the enforcement of such regulations.